Kevin McCarthy, Chemicals Anyalyst, Vertical Research Partners10.19.17
PPG Industries (PPG: Buy, $120 PT)
Volume Decent, Margins Disappoint
• 3Q EPS in line; plenty of work remains on margins though. PPG posted adjusted 3Q17 EPS of $1.52A in line with our estimate, consensus of $1.52, and the midpoint of the range of $1.48-1.55 that PPG put forth on 25 September. Sales of $3.78bn reflect modest pricing, a 2% FX tailwind, and volume gains of just under 1% after the Hurricane impacts. Regarding that late September preannounce, we were encouraged to read that excluding natural disasters, volumes would have accelerated on the quarter to 1.5%+ after the weak 2Q17 volume print of zero. However, we were also guarded as it relates to the margin potential given the elevated raw material headwinds and hurricane related costs during the quarter. Still, EBIT margin of 14.4% is disappointing and well below the 15.4% that we had penciled in. On a segment basis, Performance Coatings outperformed on sales, while margin degradation in Industrials drove incremental weakness vs. our numbers. Looking forward, PPG anticipates an additional $0.05 headwind to 4Q17 related to the natural disasters.
• Capital deployment kicks off; balance sheet still way under-leveraged. PPG repurchased $400mn worth of stock in 3Q against the company’s two-year commitment to deploy $3.5bn of excess capital by the end of 2018. Despite this capital deployment, net debt declined by $623mn q-q to 0.9x 2017 EBITDA. We note that former M&A target Akzo will host an Extraordinary General Meeting of shareholders on 30 November, just a few days before PPG regains the flexibility to re-engage, although it is not clear to us that PPG is still interested.
• Performance Coatings beat. Sales of $2.3bn came in ahead of our estimate of $2.1bn and the Street at $2.2bn. A volume decline of 1% y-y following the hurricane was offset by acquisitions, pricing and FX gains. Sales grew 3%, much improved from the -2% level reported in 2Q17. Segment EBIT of $365mn was a net EPS tailwind of $0.03 against the $353mn that we had forecast. Noticeable in company remarks however, was the mid-single digit volume weakness in EMEA coatings as business was turned away due to either lower profitability or lack of consumer acceptance of higher prices. Volumes at the protective and marine business have been a substantial headwind in prior quarters, but trended flat y-y in 3Q, likely helped by easier comps. The US DIY paint market remains sluggish, which is consistent with the downbeat commentary we continue to hear regarding coatings performance at the big box retailers. Finally, organic sales improved modestly in auto refinish, in line with prior expectations and perhaps better than those realized at Axalta, given…
• Industrial Coatings earnings missed. EBIT of $223mn came in well below our estimate of $240mn. Sales did trend ahead of our forecast, so weaker segment margins drove a negative EPS variance of $0.05. While y-y margin degradation of 230bps is actually an improvement from the -270bs reported in 2Q17, the pace is slower than we had hoped. We believe another quarter of negative y-y pricing is primarily responsible for the slower margin recovery, though the company noted price traction improved sequentially. Encouragingly, volumes in the segment grew more than 3% and FX represented an additional 1% tailwind. General industrial volumes continue to flourish, up mid-single digits, as it appears the positive economic momentum is following through to PPG sales. Packaging...
• We rate PPG shares Buy with a price target of $120. Our target suggests total upside potential of 8%, including a dividend yield of 1.6%. PPG now trades at a 2018 P/E multiple of 17.5x, which represents a discount of 3.1x or 15% vs. the average of three US coatings peers (SHW, AXTA and RPM). Importantly, we estimate that this discount would double pro forma for deployment of PPG’s excess capital vs. coatings peers. Our valuation of PPG is based on an average of two methodologies: DCF analysis and a relative P/E framework. Our DCF analysis suggests a warranted stock price of $121. Using our relative P/E framework wherein we apply a 10% premium to the S&P500 multiple, we calculate warranted value of $119 per PPG share.
Please see full report for details.
Volume Decent, Margins Disappoint
• 3Q EPS in line; plenty of work remains on margins though. PPG posted adjusted 3Q17 EPS of $1.52A in line with our estimate, consensus of $1.52, and the midpoint of the range of $1.48-1.55 that PPG put forth on 25 September. Sales of $3.78bn reflect modest pricing, a 2% FX tailwind, and volume gains of just under 1% after the Hurricane impacts. Regarding that late September preannounce, we were encouraged to read that excluding natural disasters, volumes would have accelerated on the quarter to 1.5%+ after the weak 2Q17 volume print of zero. However, we were also guarded as it relates to the margin potential given the elevated raw material headwinds and hurricane related costs during the quarter. Still, EBIT margin of 14.4% is disappointing and well below the 15.4% that we had penciled in. On a segment basis, Performance Coatings outperformed on sales, while margin degradation in Industrials drove incremental weakness vs. our numbers. Looking forward, PPG anticipates an additional $0.05 headwind to 4Q17 related to the natural disasters.
• Capital deployment kicks off; balance sheet still way under-leveraged. PPG repurchased $400mn worth of stock in 3Q against the company’s two-year commitment to deploy $3.5bn of excess capital by the end of 2018. Despite this capital deployment, net debt declined by $623mn q-q to 0.9x 2017 EBITDA. We note that former M&A target Akzo will host an Extraordinary General Meeting of shareholders on 30 November, just a few days before PPG regains the flexibility to re-engage, although it is not clear to us that PPG is still interested.
• Performance Coatings beat. Sales of $2.3bn came in ahead of our estimate of $2.1bn and the Street at $2.2bn. A volume decline of 1% y-y following the hurricane was offset by acquisitions, pricing and FX gains. Sales grew 3%, much improved from the -2% level reported in 2Q17. Segment EBIT of $365mn was a net EPS tailwind of $0.03 against the $353mn that we had forecast. Noticeable in company remarks however, was the mid-single digit volume weakness in EMEA coatings as business was turned away due to either lower profitability or lack of consumer acceptance of higher prices. Volumes at the protective and marine business have been a substantial headwind in prior quarters, but trended flat y-y in 3Q, likely helped by easier comps. The US DIY paint market remains sluggish, which is consistent with the downbeat commentary we continue to hear regarding coatings performance at the big box retailers. Finally, organic sales improved modestly in auto refinish, in line with prior expectations and perhaps better than those realized at Axalta, given…
• Industrial Coatings earnings missed. EBIT of $223mn came in well below our estimate of $240mn. Sales did trend ahead of our forecast, so weaker segment margins drove a negative EPS variance of $0.05. While y-y margin degradation of 230bps is actually an improvement from the -270bs reported in 2Q17, the pace is slower than we had hoped. We believe another quarter of negative y-y pricing is primarily responsible for the slower margin recovery, though the company noted price traction improved sequentially. Encouragingly, volumes in the segment grew more than 3% and FX represented an additional 1% tailwind. General industrial volumes continue to flourish, up mid-single digits, as it appears the positive economic momentum is following through to PPG sales. Packaging...
• We rate PPG shares Buy with a price target of $120. Our target suggests total upside potential of 8%, including a dividend yield of 1.6%. PPG now trades at a 2018 P/E multiple of 17.5x, which represents a discount of 3.1x or 15% vs. the average of three US coatings peers (SHW, AXTA and RPM). Importantly, we estimate that this discount would double pro forma for deployment of PPG’s excess capital vs. coatings peers. Our valuation of PPG is based on an average of two methodologies: DCF analysis and a relative P/E framework. Our DCF analysis suggests a warranted stock price of $121. Using our relative P/E framework wherein we apply a 10% premium to the S&P500 multiple, we calculate warranted value of $119 per PPG share.
Please see full report for details.
